Why Cronos Group's Partnership To Produce Cultured Cannabinoids Could Be A Big Deal

People pass in front of the National Access Cannabis office ready to be open in Edmonton, a unique Health Care service provider that specializes in prescribing medical cannabis, and provides members with ongoing education and care. On Saturday, August 25, 2018, in Edmonton, Alberta, Canada. (Photo by Artur Widak/NurPhoto via Getty Images)

Earlier this month, Cronos Group, a vertically integrated Canadian marijuana company, entered into a partnership with Boston-based biotech startup Ginkgo Bioworks to develop cannabinoids using organism design and development technology. Cannabinoids, which are the active ingredients that give the cannabis plant its medical and recreational properties, are likely to be among the most lucrative areas in the nascent cannabis market. Below we take a look at what the deal could mean for the company.

We have created an interactive dashboard analysis on what’s driving Cronos Group’s valuation, which allows users to modify any of our forecasts and drivers to arrive at their own valuation estimates for the company. Cronos currently trades at about 17x its projected 2019 revenues.

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Cultured Cannabinoids Could Bring Down Costs, Boost Volume

As cannabinoids account for less than 1% of the dry weight of the marijuana plant, production at commercial scale via traditional cultivation is not viable. However, with this partnership, the two companies are looking to produce cannabinoids using a fermentation process, without having to extract it from the plants. Ginkgo has expertise in using synthetic DNA to modify yeast and other organisms to produce large volumes of expensive ingredients including flavors and fragrances. Now, the two companies are looking to extend this fermentation process to produce a wide spectrum of cannabinoids, which include the psychoactive THC and non-psychoactive CBD. THC can be used to produce edible products and vaporizer cartridges and more broadly, cannabinoids can be used both for recreational and medicinal purposes. If Cronos is able to produce high-grade cannabinoid in an economically feasible manner (the company is targeting costs of under $1,000 per kilogram), it could gain a significant competitive advantage in the market.

While Cronos will fund about $22 million in research and development expenses and production costs, it will compensate Ginkgo in stock (up to 14.7 million shares of Cronos stock) as certain milestones are reached, in exchange for its expertise. Cronos will have the right to use and commercialize the intellectual property involved. While this would dilute existing Cronos shareholders as targets are met, we believe the structure of the deal makes sense for the company as it limits costs and reduces some downside risk, while providing substantial upside.